Monday, December 17, 2012

Pay and Performance at Public Plans?

Britt Harris arrived at the Teacher Retirement System of Texas in 2006 from the world’s biggest hedge fund with a mandate to improve the pension’s performance. He also brought a Wall Street attitude about pay.

Harris, the Texas fund’s chief investment officer, made $1 million last year in salary and bonuses, the most of any public pension employee in the 12 most populous U.S. states, according to data compiled by Bloomberg. Four other employees made at least $500,000, and the fund paid $9.7 million in bonuses in 2011, more than any in those states.

Funds where executives made far less posted better investment results than those produced by Harris and his staff over three and five years. They included, respectively, the Ohio Police & Fire Pension Fund, where the top-paid executive last year was William J. Estabrook, at $231,614, and the New Jersey Division of Investment, where director Timothy Walsh made $185,000 plus $7,500 for moving expenses, data show.

“These guys may claim to be worth their weight in gold,” said Edward Siedle, a former U.S. Securities and Exchange Commission attorney and president of Benchmark Financial Services of Ocean Ridge, Florida. “They absolutely can’t justify it.”

Falling Behind

While Harris says public pension compensation must be competitive with the private sector to attract top talent, the Texas fund -- seventh-largest in the U.S. with $112.4 billion in assets -- is falling further behind in long-term obligations to more than 1.3 million education employees and retired teachers, including Harris’s mother.

The pay-and-performance disparities at public pension funds are among the findings of a data review in which Bloomberg compiled payroll records for 1.4 million employees of the 12 largest states.

Of the highest-paid pension executives in those states last year, all but two worked at the Texas fund or the State Teachers Retirement System of Ohio, data show. Yet the Texas fund’s 2.12 percent return over five years as of June 30, 2012, net of fees, was less than five other state pensions, including the New Jersey pension plan, which returned 2.46 percent. The Texas fund’s three-year results of 13.17 percent trailed Ohio Police & Fire, which returned 13.25 percent.

Harris, who became chief investment officer in December 2006, was hired by a board of trustees appointed by the governor. He said it isn’t fair to judge his returns before 2009. It’s only since then that his strategy has been completely in place after attracting the investment talent he needs, Harris said.

‘Come Home’

“You get a better car, then you’ve got to have a good driver,” Harris said in an interview. “This whole structure has been like a magnet to all these investors from around the country to kind of come home to momma, come home and serve the teachers.”

The Texas fund’s three-year return was just ahead of the State Universities Retirement System of Illinois and the Pennsylvania Public School Employees’ Retirement System. Their top-paid executives earned $221,346 and $269,302, respectively, the data show. Neither fund pays bonuses.

“Strictly looking at performance for pay, there are a lot of people who are paid only mediocre salaries that deliver excellent performance,” said Charles Skorina, an executive recruiter retained by the boards of institutional investors to identify and hire investment professionals.

‘Loose’ Correlation

He found “a very loose correlation between pay and performance in public plans,” based on an analysis of the pay of chief investment officers and pension returns over five years.

The Texas teachers’ pension plan was 81.9 percent funded as of Aug. 31, down from 82.7 percent funded in 2011, 82.9 percent in 2010 and 83.1 percent in 2009. These percentages show how much money the fund projects it will have compared with its obligations to retirees over the long term. When a fund falls further behind on them, taxpayers have to make up the difference. The U.S. median for states fell to 71.7 percent in 2011 from 82.6 percent in 2007, according to data compiled by Bloomberg.

While retired teachers in Texas don’t oppose bonuses to keep good staff, they think the payments are too high and reward too many employees, said Tim Lee, executive director of the Texas Retired Teachers Association in Austin.

“They don’t like the fact that people are getting bonuses and raises but our retirees haven’t had a raise for 12 years,” Lee said in a telephone interview. “If we are the best, then we must perform better than anybody else.”

Pay, Bonuses

Harris’s compensation included $480,000 in annual pay plus $565,792 in bonuses earned in 2009 and 2010, according to the pension. He is scheduled to make $900,752 in 2012, including his annual salary, plus bonus amounts of $222,277 and $198,475 earned in 2010 and 2011, the fund said.

Harris, 54, joined the Texas system after managing the pension fund at Verizon Communications Inc. (VZ) and six months as chief executive officer at Bridgewater Associates LP, the world’s biggest hedge fund, based in Westport, Connecticut.

He was hired to improve a fund with below-average performance that was not well diversified, Harris said. With approval from the state legislature, Harris began ramping up stakes in so-called alternative assets including private equity and hedge funds. Alternatives have risen to 32.1 percent of assets from 4.1 percent in 2006, according to the fund.

Attracting Talent

Harris said he also sought to attract investment talent appropriate for one of the world’s 20 largest pensions. That, he said, addresses the “travesty” and “sin” of a public pension fund paying less to an investment staff working for retirees than private-sector managers earn at smaller funds serving affluent clients.

Standing at a white board in front of the conference table in his Austin office, with a panoramic view of the Texas Statehouse, Harris drew a diagram showing the scale of investment compensation at all pension funds, public and private.“These people right here are being cheated,” he said, pointing to public funds at the bottom.“It’s crazy to think about the fact that the way the world works is the largest, most important funds are expected to compensate people the worst,” Harris said.

After hiring a consultant to complete a comprehensive review of pay, Harris said he increased base salaries to the top quarter of public funds and bonuses to match the bottom 25 percent of private funds.

Incentive Changes

He changed the incentive program, which had paid bonuses of as much as 75 percent of base salaries only to investment directors, managers and executives. Awards now range from as much as 5 percent of base salary for administrative staff to as much as 125 percent for top officials. Bonuses are paid over two years, as long as an employee remains with the system.

Bonus pay at the fund increased from $622,918 for 34 employees in 2007 to $9.7 million for 108 in 2011, which included incentives earned in 2008, 2009 and 2010 and paid last year when the fund reached positive returns, according to records provided by fund. This year, Texas Teachers paid $6.1 million in incentives and expects to pay $6.9 million in February, records show.

With bonuses, 63 of the fund’s employees, or about 10 percent, made more than Republican Texas Governor Rick Perry’s $150,000 annual salary without his state pension last year, data show.

Good Stewards

The Texas Teachers Board of Trustees has a duty to act in the best interests of the people they serve while being good stewards of taxpayer dollars, said Josh Havens, a spokesman for Perry.

“Governor Perry expects the board to do its job,” Havens said in an e-mail.

The pension with the next-highest bonuses, State Teachers Retirement System of Ohio, paid $8.1 million to 88 workers last year, data show. That included $3.1 million in bonuses earned in 2009 but deferred until the pension reached $65 billion in assets last year, the fund said.

The California Public Employees’ Retirement System, the largest public pension in the U.S., paid $4.1 million to 50 workers in 2011, the fund said.

By comparison, the three highest-performing funds over the past 10 years, the Pennsylvania School Employees Retirement System, Ohio Police & Fire Pension Fund and Pennsylvania State Employees’ Retirement System, didn’t have an employee paid more than $270,000, and none pays bonuses, the funds said.

Since Harris joined the Texas fund in December 2006, Texas Teachers has paid $20 million in bonuses, records show.

‘Go Along’

A 2009 memo submitted to the Texas system’s board of trustees by Michael Green, one of the fund’s former senior managers, said Harris’ approach to running the system can be summarized in two phrases: “You’re too skeptical” and “You’ve got to go along to get along.” Reached by telephone, Green declined comment other than to say he stands by the memo.

While Harris said he can’t comment because Green is a former employee, he said, “I don’t need to get along with anybody” and “this is a job that I want to be in, not that I have to be in.”

Top public pension fund executives make less than their counterparts at investment-management companies. Compared with the $1 million Texas system paid Harris last year, Waddell & Reed Financial Inc. (WDR), with $95 billion now under management, paid Michael Avery, its president and chief investment officer in 2011, total compensation of $4.6 million that year, according to the Overland Park, Kansas-based company’s proxy statement.

Bonuses Falling

Yet bonuses are falling for money managers in the private sector. Wall Street’s cash bonus pool is likely to fall for a second straight year in 2012 as the financial industry grapples with market turmoil, economic weakness and new rules, New York state Comptroller Thomas DiNapoli said.

The average Wall Street bonus fell 13 percent to $121,150 in 2011, the lowest since 2008, and down almost 40 percent from a peak of $191,360 in 2006, according to estimates by DiNapoli.

Harris didn’t take an estimated bonus of $167,835 in 2009 after the TRS fund experienced a 27 percent drop in its market value in 2008. The fund pays bonuses even if the fund loses money -- deferring the payments until returns are positive again -- as long as employees beat their investment benchmarks, according to the plan.

Core Culture

Under Texas Teachers’ program, bonuses are calculated based 80 percent on investment performance against asset-class benchmarks and peer groups, with 20 percent based on how each employee rates against “core culture items” of candor, curiosity, accountability, teamwork and leadership, and promoting a constructive work environment, said Susan Wade, director of professional development.

Lee at the Texas Retired Teachers Association sent a letter to board trustees in June seeking to lower the amount of bonuses employees are eligible to earn, to raise the benchmarks used to qualify for a bonus and to limit the number of workers who qualify. The board didn’t agree, said Lee, the association’s executive director.

Among large, statewide pension plans, about one-quarter to a third have some sort of performance incentive program for their investment staff, said Keith Brainard, research director at the National Association of State Retirement Administrators.

Anecdotal Reports

Brainard said he hears growing anecdotal reports about retirement funds having difficulty attracting and retaining qualified investment staff, and that Harris and many asset managers could easily double or triple their compensation in the private sector. If they were working for an external money manager, most people wouldn’t be concerned, he said.

About 80 percent of the Ohio teachers’ $65 billion fund is managed internally by about 100 investment professionals, said Stephen Mitchell, deputy executive director of investments.

That includes Mary Ellen Grant, the fund’s highest-paid employee last year at $678,291. She oversees a staff of 35 that handles almost 90 percent of its real estate holdings, while other funds rely on more expensive external managers, spokesman Nick Treneff said. The fund’s three-year return on investments, net of fees, was 12.40 percent and its five-year return was 0.97 percent.While relying on internal staff can inflate compensation totals, it’s more cost effective than paying external managers, Mitchell said in an interview in Columbus. He said an analysis by CEM Benchmarking concluded the Ohio Teachers’ fund saved $91 million in 2011 alone by managing assets internally compared with peer median costs to use external managers.

“Our costs are very low for what we do,” Mitchell said.

No Guarantee

Even so, there’s no guarantee that active management and higher compensation will produce better results, and funds can get competitive returns with passive management using external managers, said William Mabe, head of the State Universities Retirement System of Illinois. Mabe earned less than a third of what Grant was paid in 2011 and a quarter of what Harris made.

Mabe’s fund posted returns that ranked third-best among 20 funds in the 12 largest states over three years and 8th highest over five years, while Mabe’s compensation was lower than that of the top executives of all but three of the 20 plans.

“At the end of the day,” Mabe said in a telephone interview, “returns are really what matter.”

Mabe is right, there’s no guarantee that active management and higher compensation will produce better results, and at the end of the day, returns are what really matters.

Last Monday, I discussed Virginia's bonus bonanza, going over the ridiculous practice of paying out bonuses in years where funds are losing money. Texas Teachers also pays bonuses when the fund is losing money but at least they defer payments until returns are positive (smart move to avoid political flack!).

Still, the article above clearly demonstrates that there is no strong link between pay and performance at US public plans. In fact, I'm not surprised that Charles Skorina of Charles Skorina & Company found “a very loose correlation between pay and performance in public plans.”

That may be true but in general, you get what you pay for. Having said this, there are excellent pension fund managers who make far less than Brit Harris and are producing better results. Many of these outperformers stick to nuts and bolts and don't lose their minds over alternative investments.

I can write the same thing about Canadian funds which pay their top people a hell of a lot more than any US pension fund. If you look at bcIMC which keeps it simple, you'll see strong, robust long-term results that are just as good, if not better, than any of the other large funds. And none of their top managers receive the multi-million dollar bonuses their counterparts receive.

In private conversations I've had with a few presidents of large Canadian funds, they admitted to me that they're overpaid. You'll often hear "but that's the market" and "we can get fired at any time." Sure they can, but that rarely happens and even if it does, they get a sweet severance package.

One other thing I noticed from the article above is that Texas Teachers pays bonuses based on two-year performance. This is silly. It should be a minimum of four years (if not more) as it is in Canada and elsewhere.

...at OTPP it is a 4y rolling until it isn't. What I mean is when 2008 rolls around and it potentially deep-sixes bonuses for the following four years, management makes a case that keeping the 4y rolling including 2008 performance will make it difficult to attract / retain talent and this justifies restarting the 4y avg from 2009 - so it only stays 4y avg as long as it suits management.

I don't know if this is true but will verify it once results from Ontario Teachers' and other large Canadian pension funds are made available. I find the practice of resetting bonuses by removing bad years disgusting, immoral and possibly illegal depending on how you interpret the legislative acts governing these public pension funds.

Hedge fund managers only wish they can reset their bonuses to remove bad years but in their fiercely competitive world, if you don't perform, you get no bonus (but you still collect a 2% management fee which is substantial for funds managing multi billions). Moreover, hedge funds have a high water mark, which means they have to make up all their losses before they can start charging the 20% performance fee again. Similarly, in private equity you have clawbacks but they remain a hot issue.

The whole issue of compensation in finance is very touchy and extremely sensitive. I happen to think public pension fund managers are grossly underpaid relative to private sector fund managers but I also think most people in finance are obscenely overpaid, making way more than teachers, police officers, firemen, nurses, civil servants and even doctors (and trust me, people in finance are not brain surgeons!).

At the end of the day, public pension funds should pay for risk-adjusted performance and make sure that this performance is based on clear targets and there's no gaming of benchmarks. I think board of directors have a duty to make sure compensation is fair, clear, transparent and in the best interests of all stakeholders. They should also be aware of what is going on in the private sector and adjust compensation accordingly.

Below, Britt Harris, chief investment officer of the Teacher Retirement System of Texas, talks with Bloomberg's Mark Niquette about the fund's performance and employee compensation.

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I am an independent senior pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest. Please remember to support my efforts by clicking on the ads on the blog but more importantly by contributing via PayPal clicking on the buttons below. Anyone can contribute any amount at any time (all tips are greatly appreciated) but institutional investors are kindly requested to support this blog via an annual subscription of $500, $1000 or $5000 CAD (third option includes specialized consulting mandates). For all inquiries and comments, email me at LKolivakis@gmail.com.

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